CFPB Said What

If you have not checked out Tom Brown's commentary on the Consumer Financial Protection Bureau (CFPB) and auto financing for service members, I believe you should.

According to the post, "the CFPB thinks it’s a problem that service members can’t take their financed vehicles with them when they get deployed overseas."

I think most, if not all, lenders would think this is not a good idea.

Banks and credit unions that serve the armed forces need to pay close attention to this development.

Read Tom Brown's Commentary.

Material Loss Review on Southwest Corporate FCU

The failure of Southwest Corporate FCU (Southwest) will cost the Temporary Corporate Credit Union Stabilization Fund (TCCUSF) $141 million, according to a recent report released by NCUA's Office of Inspector General (IG).

The IG report found that the failure of Southwest can be attributed to management's implementation of an aggressive investment strategy that led to a significant concentration of investments directly in privately-issued residential mortgage backed securities (MBS) and additional indirect exposure through U.S. Central Federal Credit Union’s investments in MBS.

Between March 2004 and July 2007, Southwest increased its direct concentration of privately-issued MBS 263% from $1.39 billion to $5.05 billion. This growth in its private-label MBS was fueled by an increase in Southwest's investment policy limit from 400% of capital in 2004 to 900% of capital in 2006.

In 2007, approximately two-thirds of Southwest’s $4.8 billion MBS exposure was collateralized by riskier non-prime mortgages, just when the housing market became dislocated.

Moreover, its MBS exposure was heavily concentrated in one state -- California. The California concentration represented 319 percent of Southwest’s capital.

The IG report also criticized NCUA Office of Corporate Credit Unions (OCCU) staff. It found that staff did not adequately and timely address the risks associated with Southwest’s direct concentration of and indirect exposure to privately-issued MBS. The report also criticized OCCU staff for not taking exception to the geographic concentration of Southwest's private-label MBS portfolio.

Read the report.

NCUA No Need for Cost-Benefit Analysis on All Proposed Rules

In a speech to NASCUS State System Summit, NCUA Board member Michael Fryzel was dismissive of the notion that the agency should conduct a cost-benefit analysis regarding every regulation the agency proposes.

Board member Fryzel said:

"I also do not believe we should write a report on the cost-benefit analysis of every regulation NCUA proposes. Doing so would be too burdensome, or necessitate hiring additional employees. In any event, the intended benefits are generally obvious in the regulations we propose, and, indeed, many comments point out potential costs -- we need not duplicate those efforts."

However, the Office of Management and Budget (OMB) in September 2003 wrote:

"A good regulatory analysis should include the following three basic elements: (1) a statement of the need for the proposed action, (2) an examination of alternative approaches, and (3) an evaluation of the benefits and costs—quantitative and qualitative—of the proposed action and the main alternatives identified by the analysis."

OMB goes on to write that good analysis is transparent and provides specific references to all sources of data.

It is unacceptable for NCUA to state that the intended benefits of the proposed rule are obvious and that commenters can point out the potential costs.

Furthermore, Fryzel's comment places the agency on a possible collision course with Senator Shelby of Alabama. Senator Shelby recently introduced the Financial Regulatory Responsibility Act of 2011 (S 1615).

According to the press release, "the legislation holds financial regulators accountable for rigorous, consistent economic analysis on every new rule they propose. It requires them to provide clear justification for the rules, and to determine the economic impacts of proposed rulemakings, including their effects on growth and net job creation. This bill also improves the transparency and accountability of the regulatory process and reduces the burdens of existing regulations. In addition, the legislation mandates that if a regulation’s costs outweigh its benefits, regulators are barred from promulgating the rule."

Net Worth Assistance Coming to Troubled Credit Unions

The NCUA Board approved net worth assistance for credit unions that are in danger of failing.

Section 208 of the Federal Credit Union Act allows the Board, in its discretion, to make loans to, or purchase the assets of, or establish accounts in insured credit unions the Board has determined are in danger of closing or in order to assist in the voluntary liquidation of a solvent credit union.

ABA believed that this assistance should only be provided in the case of a merger of a failing credit union into a healthy credit union. It was not meant to be used as a vehicle to prop up credit unions that are in danger of failing.

According to NCUA Chairman Matz's December 2010 testimony, she pointed out that when a healthy credit union acquires a failing credit union, this resoluted in a delusion of the healthy credit union's net worth. Without the ability of counting assistance from NCUA as net worth, this "necessitates more outright liquidations instead of mergers," which would increase the resolution cost.

However, NCUA disagreed with ABA's viewpoint. NCUA wrote that there was no language limiting section 208 assistance to situations only involving a merger. Therefore, section 208 assistance can be provided directly to a troubled credit union and be counted as part of a credit union’s net worth.

Furthermore, NCUA stated that it would not disclose the name of credit unions receiving section 208 assistance and will not include a line item regarding section 208 assistance in the 5300 Call Report.

NCUA wrote that if it made public information about credit unions receiving section 208 assistance, there was a strong possibility that members may perceive the credit union as weak and unstable. Let me make one thing clear -- if a credit union is getting section 208 assistance, it is because it is weak and unstable.

Perhaps, the news media will mount a legal challenge to NCUA's decision to not disclose which credit unions receive section 208 assistance.

Chetco FCU Placed into Conservatorship

The National Credit Union Administration (NCUA) assumed control of service and operations at Chetco Federal Credit Union of Harbor, Ore.

Chetco FCU had approximately $333 million in assets at the end of June 2011.

Chetco FCU reported a loss of almost $17 million for 2010 and a loss of $212,215 for the first six months of 2011.

As of the end of June 2011, the credit union was undercapitalized with a net worth ratio of 5.02 percent. Chetco reported that $57.8 million in loans that were 60 days past due or 19.02 percent of its loans were delinquent.

Part of Chetco's problems arose from loan participations. Chetco FCU had $70.5 million in outstanding loan participations (about 23 percent of its loan portfolio) and almost 17.5 percent of these loan participations were delinquent.

The credit union reported holding $10.1 million in foreclosed real estate loans.

Read the press release.

Problem CU Update

NCUA reported today that the number of problem credit unions, assets in problem credit unions, and deposits (shares) in problem credit unions fell in August.

A problem credit union has a CAMEL rating of 4 or 5.

At the end of August, there were 369 problem credit unions -- down from the recent high of 381 credit unions in June.

Assets and shares in problem credit unions were to $34.8 billion and $30.9 billion, respectively. The percentage of the industry's assets and shares in problem credit unions were 3.5% and 3.96%.

The decline in assets and deposits in problem credit unions in August arose from one $1 billion plus credit union and two credit unions with between $500 million and $1 billion no longer being rated as a CAMEL 4 or 5. These three institutions accounted for a combined $5.7 billion decline in deposits on the problem list.

NCUA Tapped Line of Credit at Treasury on July 27

According to the August 29 transcript from the NCUA Board meeting, NCUA tapped its line of credit at the Treasury in July.

NCUA Chief Financial Officer, Mary Ann Woodson, stated:

"On July 27 NCUA borrowed $3.5 billion from Treasury to satisfy the balance of the bridge note payable and other miscellaneous obligations which were paid on October 1, excuse me, which were paid on August 1, 2011."

Mary Ann Woodson also acknowledges that NCUA anticipates borrowing a total of $5.5 billion from the Treasury of its $6 billion line of credit to meet near-term cash flow needs.

While credit unions will ultimately repay this borrowing, tax-exempt credit unions are receiving valuable assistance from the U.S. Treasury and ultimately the American taxpayer.

This borrowing does not count other assistance that came from the Treasury. For example, Treasury lent funds to the Central Liquidity Facility that were funneled to two corporate credit unions to keep them afloat and prevent a systemic collapse of the credit union industry.

So whether credit unions want to recognize it or not, they were bailed out.

NCUA Announces Upcoming Regulatory Agenda

In a speech on September 19 before the National Association of Federal Credit Unions, NCUA Chairman Debbie Matz announced the forthcoming regulatory agenda for the NCUA.

Debbie Matz said in her speech: "[M]y goal is to target risky behaviors in credit unions, not credit unions themselves."

The NCUA chair stated that the agency will move forward with its plans to finalize its CUSO transparency and interest rate risk rules. Additionally, Chairman Matz noted some new proposed regulations that will be issued this fall or next year.

First, NCUA Board plans to consider a Loan Participation Protection rule, which will cover both originators and buyers of loan participations. NCUA will require originators to keep some “skin in the game” so as to provide "a disincentive for the kinds of reckless behavior that puts the Share Insurance Fund at risk." The proposed rule would also require participating credit unions to investigate these loans thoroughly – not just at origination, but over the life of the loan.

Second, NCUA will propose an Investment Concentration Exposure Limits rule, which will be aimed at limiting concentrations in the riskiest investments, like private-label mortgage-backed securities and collateralized debt obligations.

Third, NCUA will propose extending six of the seven remaining Regulatory Flexibility (RegFlex) provisions to all federal credit unions. The seven remaining RegFlex provisions are:

1. charitable contributions;
2. nonmember deposits;
3. ownership of fixed assets;
4. zero coupon securities;
5. borrowing repurchase transactions;
6. commercial mortgage related securities; and
7. purchase of obligations from federally-insured credit unions.

Ms. Matz also called on credit unions to lobby Congress for the authority to issue secondary capital and lifting the business loan cap.

Read the speech.

Governor Perry Calls for Lifting Business Loan Cap

Speaking before the Iowa Credit Union League’s annual convention, Governor Rick Perry called for the federal government to lift the 1998 cap that limits credit union business loans to 12.25 percent of their assets, which he called arbitrary.

Read more.

Unpublished Enforcement Actions

On September 1, the NCUA's Office of the Inspector General (IG) issued two Material Loss Reviews on the failures of Certified FCU and Constitution Corporate FCU. The reports noted that both credit unions were under enforcement actions at the time of their failure.

The IG report on Certified FCU states that credit union was issued a Letter of Understanding after its June 2009 examination.

In a separate IG report, a Letter of Understanding and Agreement (LUA) was issued to Constitution Corporate FCU following its August 2008 examination. The consent order "contained several provisions pertaining to policies and strategies to address liquidity, credit concentration limits, and capital adequacy concerns."

However, these enforcement actions were never published. According to a footnote in the Certified FCU Material Loss Review, when an enforcement order is unpublished, the administrative remedy is considered an informal action.

I know that I sound like a broken record on this subject. But if NCUA believes that credit unions are owned and controlled by their members, then publish the enforcement actions. The members have a right to know.

Credit Union Mergers

A recent Federal Reserve Bank of San Francisco's Economic Letters on credit union mergers concluded that credit union mergers have shifted from, on average, only benefiting merger targets to also benefiting acquirers to some extent.

The paper looks at 9,412 credit union mergers from 1984 to 2009. The paper put credit union mergers into three categories -- absorptions, in which targets had less than 10% of the acquirer’s assets; acquisitions, in which targets had 10–50% of the acquirer’s assets; and mergers of equals, in which targets had more than half of the acquirer’s assets.

The study found that absorptions accounted for 69% of targets, but only 33% of target assets; acquisitions accounted for 25% of targets and 40% of target assets; and mergers of equals accounted for 6% of targets and 22% of target assets.

The study found that "in the first year after mergers, aggregate noninterest expenses fell by 0.02 percentage point in absorptions, 0.13 in acquisitions, and 0.20 in mergers of equals."

The study also found that five years after a merger of equals the cost savings had been completely dissipated, while acquisitions had retained a larger portion, if not all, of their cost savings.

Read the article.

Efficiency Ratio, June 2011

The California Department of Financial Institutions (DFI) announced that it is incorporating the efficiency ratio into its examination of state chartered credit unions.

The state regulator noted that examiners often commented on credit union efficiency, but were not able to quantify performance. Using the efficiency ratio will give examiners another tool to better identify and communicate the earnings performance of credit unions.

Specifically, the efficiency ratio measures the cost of generating an additional dollar of revenue. The efficiency ratio equals total non-interest expense divided by [(total interest income - total interest expense) + fee income + other operating income + other non-operating income].

The DFI stated that the efficiency ratio has a long history of being used within the financial services industry as a key earnings metric, although NCUA does not consider it a key ratio. The DFI , however, stated that the efficiency ratio is only a part of the picture and does ignore non-financial considerations by credit unions.

As of June 2011, the unweighted average efficiency ratio for the credit union industry was 90.53%. The median efficiency ratio for the credit union industry was 86.10%.

As a general rule, the larger the credit union, the lower the efficiency ratio.

Below is some benchmarking statistics by asset size groups as of June 2011.

For credit unions with $1 billion or more in assets, the average efficiency ratio was 66.30% but half had an efficiency ratio in excess of 66.59%. Credit unions with an efficiency ratio at or below 60.10% were in the top (first) quartile. Star One Credit Union had the lowest efficiency ratio at 27%, while Indiana Members Credit Union had the highest efficiency ratio at 93.10%.

For credit unions with assets between $500 million and $1 billion, the average and median efficiency ratios were 73.60% and 73.94%, respectively.

For credit unions with assets between $250 million and $500 million, the average and median efficiency ratios were 76.61% and 77.91%, respectively.

For credit unions with assets between $100 million and $250 million, the average and median efficiency ratios were 79.90% and 80.08%, respectively.

For credit unions with assets between $50 million and $100 million, the average and median efficiency ratios were 83.29% and 84.05%, respectively.

For credit unions with assets between $10 million and $50 million, the average and median efficiency ratios were 87.17% and 87.4%, respectively.

For credit unions under $10 million, the average and median efficiency ratios were 103.16% and 93.75%, respectively.

Special Premium for Privately Insured CUs

American Mutual Share Insurance Corporation (ASI) announced a Special Premium Assessment for 2011 of 15 basis points on total shares (deposits) as of June 30, 2011. The premium will be assessed of all primary insured credit unions of record on September 30, 2011, subject to final regulatory approvals.

The premium assessment does not apply to excess share insurance policyholder credit unions insured by Excess Share Insurance Corporation (ESI) or ASI.

ASI stated that the special premium assessment was due to lower yields on its government bond portfolio and weaknesses at a small number of member credit unions in select markets, which have required a more aggressive funding of loss reserves by ASI.

Read the press release.

Material Loss Review Issued on Constitution Corporate FCU

NCUA's Office of the Inspector General (IG) issued its report on the failure of Constitution Corporate FCU. NCUA estimated as of July 2011 that the failure of Constitution Corporate FCU resulted in a loss of $145 million to the Temporary Corporate Credit Union Stabilization Fund.

This IG report is similar to the other IG reports that examined the failures of other corporate credit unions.

The Material Loss Review cites that management and Board failed to identify and manage their risk exposure to the mortgage-backed securities (MBS) prior to the market dislocation in mid 2007. At that time, Constitution Corporate had significant holdings of private label MBS including Alt-A and subprime paper.

Constitution Corporate's decision to expand its investments into private label MBS was driven by the need to be rate competitive with other corporate credit unions that were actively soliciting Constitution Corporate's members.

The IG report notes that:

1. there was an over-reliance on credit ratings by management when purchasing securities and monitoring credit risk in the investment portfolio;

2. management did not set prudent sector concentration limits;

3. management did not properly identify and monitor credit risk exposure in the underlying mortgage loan collateral of MBS held in the investment portfolio; and

4. management did not recognize the risk they were undertaking with significant investments in complex MBS, with a substantial portion of these securities backed by subprime assets.

The report also criticizes NCUA for failing to assess or timely identifying key risks associated with Constitution Corporate FCU's investment portfolio, until it was too late.

Read the report.

IG Report: Ethic Breaches Played a Role in Certified FCU's Failure

The Inspector General (IG) found that Certified FCU failed because of weak internal controls, weak board oversight, and inadequate risk management practices. The failure of Certified FCU resulted in a loss of $9 million for the National Credit Union Share Insurance Fund.

The IG report found that improprieties and fraud played a major role in the credit unions failure. According to the IG report, allegations of fraud and improprieties first surfaced through anonymous telephone calls to the NCUA in April and May of 2005. However, a 2005 investigation by NCUA found no evidence to substantiate the fraud allegations, although they determined the CEO had abused his position to enrich himself personally at the credit union’s expense and potentially engaged in money laundering. The report notes that NCUA officials failed to take decisive action about these ethical breaches and the CEO stayed in his position until May 2010.

A 2010 forensic review found evidence that there was a breach in the fiduciary duties by the CEO, including check kiting and receiving "potential kick backs from vendors and from loan origination fees and commissions paid to one of the Credit Union’s loan officers."

For example,

"The CEO had a consulting company, which contracted for a 20 percent share of commissions paid to the loan officer’s mortgage servicing business. The loan officer generated low quality loans with high origination fees, which were then approved by the CEO. The loan origination fees were paid by Certified in the form of commissions to the loan officer’s company, which then paid the CEO’s consulting business its 20 percent share."

Additionally, the report notes that the credit union failed to manage liquidity risk. High cost nonmember deposits, which I've previously written about with respect to other credit union failures, rose to 18 percent of total deposits increased the liquidity problems confronting the credit union, especially given its heavy concentration of fixed rate real estate loans.

Additionally, the IG report found that NCUA examiners failed to:

1. adequately assess the management component of CAMEL rating system;

2. adequately consider external audit findings and reviews when developing their examination procedures; and

3. appropriately apply remedies when their fraud investigation unearthed serious safety and soundness concerns due to the CEO’s business practices and ethical behavior.

Read the IG Report.

Association Bond Satisfies Field of Membership Issues Related to Rare CU Bank Merger

Credit Union Journal (paid subscription) is reporting that United FCU is using an associational common bond as a vehicle to allow all the depositors of Griffith Savings Bank to join the credit union.

The depositors of Griffith Savings Bank by joining the American Consumer Council become eligible for membership in United FCU, thereby satisfying the field of membership issues related to this rare transaction. The transaction is still awaiting regulatory approval.

This is just another example of how some credit unions have used an associational common bond to make a mockery out of the concept of a common bond and to allow them to serve the public at large.

Credit Unions Performance in the 2nd Quarter

NCUA is reporting that key indicators for federally insured credit unions (FICUs) either stabilized or improved in the second quarter of 2011.

FICUs reported net income of $1.88 billion for the second quarter bringing year-to-date profits to $3.58 billion. The return on assets rose from 74 basis points at the end of the first quarter to 77 basis points at the end of the second quarter. In comparison, the return on assets was 41 basis points a year ago.

Net interest margin was virtually unchanged increasing by 1 basis point during the quarter to 3.17 percent, while net operating expenses as a percent of average assets was unchanged at 2.43 percent. The low interest rate environment caused the cost of funds as a percent of average assets to fall 25 basis points from December 2010 to 0.96 percent as of June 2011. FICUs also reported reducing their provisions for loan and lease losses during the second quarter.

The stronger earning at FICUs caused the net worth of FICUs to increase by 2 percent during the quarter to $95.6 billion. Coupled with slower asset growth, the net worth ratio for FICUs rose by 17 basis points to 10.14 percent at the end of the second quarter.

Credit unions reported that assets and shares (deposits) at credit unions rose during the quarter. Assets increase by 0.3 percent to $942.5 billion, while shares increased by 0.1 percent to $812.2 billion.

NCUA noted that loans edged higher by 0.7 percent during the second quarter to $564 billion -- reversing three consecutive quarter of declining loan volume. Outstanding new car loans and other real estate loans fell during the second quarter, while used car loans, first mortgages, and credit card loans increased during the quarter.

NCUA reported that almost $8.9 billion in loans was sixty days or more past due -- down from $9.1 billion in the first quarter. The delinquent loan ratio fell for the second consecutive quarter to 1.58 percent, a 5 basis point reduction from the first quarter. However, loans that are 12 months or more past due rose during the quarter from $1.54 billion to $1.59 billion.

Credit unions reported a slowing in the pace of charge-offs during the second quarter. Charge-offs for the second quarter were less than $1.5 billion compared to slightly more than $1.6 billion for the first quarter of 2011.

Read the press release.